S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to today's webinar. My name is Paul Bishop, and I am a Director in the Credit Risk Solution team in Asia Pacific at S&P Global Market Intelligence. During this challenging time, I would assume that most of you are joining this webinar from home. And I would like to thank you on taking your valuable time to listen to my colleagues and I as we share practical insights on how you can accelerate your progress on climate risk. Before we begin the webinar, I'd like to give you a quick overview of the screen in front of you. Along the bottom of your screen, you'll see some icons that you may not be familiar with. These are the various widgets associated with the presentation today. The first 3, you should already be viewing, which are the presentation slides, the list of today's speakers and the question-and-answers box. You can move, maximize or minimize any of these boxes at any time. In the resources box, you will also be able to view some materials relating to climate risk as well as some of the on-demand webinars that we have recently concluded focused on climate risk. In addition, we had a lot of questions about COVID in the pre-submitted questions. Here, I would like to point your attention to a link within the resources list, where you can access the essential intelligence that you need to track the business and economic impacts from corporate credit to supply chains relating to the current pandemic situation. Please feel free to submit questions throughout the presentation or during Q&A session towards the end of the broadcast, and we'll try to answer as many as possible. Lastly, please note that the activities of S&P Global Market Intelligence are independent and separate from S&P Global Ratings. And now let's go over to today's agenda. So I shall now invite our first speaker, Steven Bullock, who's Global Head of Research from Trucost, which is a part of S&P Global. Steve will talk about how climate risk is changing across regions and through times. Over to you, Steven.

Thanks, Paul, and good afternoon, everybody. So in recent weeks, we started to see news reports on the connection between the coronavirus pandemic and climate-related issues. The slowdown in nonessential travel and industrial activity has led to improved air quality in major cities around the world, and scientists predict that global CO2 emissions may drop by more than 5% this year in what would be the largest fall since the end of the Second World War. While these indirect house and societal impacts offer no cause for celebration right now, the pandemic may offer an opportunity to pause and think about how we tackle other systemic risks such as climate change in the future. In the next few decades, millions of lives and trillions of dollars will be at risk due to rising CO2 emissions and a changing climate. The World Economic Forum's global risks report published in January of this year cites extreme weather events and climate action failure as the largest risks in terms of impact and likelihood. If business-as-usual resumes after the pandemic, CO2 emissions will likely jump to 50 gigatonnes by 2050 from around 35 gigatonnes today. As such, much more rapid emissions reductions are needed to keep global temperature increases to below 2 degrees Celsius, which is the goal, as you may know, of the Paris Agreement. For that to happen, global annual CO2 emissions would need to fall more than half to about 15 gigatonnes by 2050. So as the world works to address these challenges, assets, companies and investment portfolios will be exposed to rising climate change transition, physical and reputational risks. So now I'm going to explore how these risks are changing across regions and through time using a set of data visualizations that we developed for the World Economic Forum event series earlier this year. So you'll see a number of short videos playing throughout the presentation, and there might be a slight delay of 5 to 10 seconds on the playback. So don't worry if you experience this. On to the first slide, let's begin by reviewing the global asset holdings of the S&P 500 Index of the largest U.S. companies. S&P 500 companies own physical assets across 68 different countries, which you can see on the slide right now, with 60% representing a market cap of around $18 trillion holding at least 1 asset at higher risk of the physical effects of climate change. These assets are shaded in red on the visual. The most significant physical risks for S&P 500 -- for the S&P 500, sorry, are associated with heatwaves, wildfires and sea level rise as well as hurricanes. And while some sectors, particularly highly capital and water-intensive sectors, may be disproportionate risk, the exposure of individual companies will be determined by the location of each company's operational asset holdings. So on to the next visual and a animation will start playing on the screen right now. So climate change raises sea levels by increasing ocean temperatures, which causes water to expand; and by melting glaciers and ice sheets, which adds water to the oceans. Global sea levels have risen by an average of about 8 to 9 inches since 1880, and climate change is projected to further accelerate sea level rise. Before land is permanently submerged, rising seas will lead to higher and more frequent coastal flooding. So now let's look at the -- specifically at the S&P 500 real estate assets in the city of New York, which is showing on the screen now. Assets are represented by the blue dots and inundated areas at each level of sea level rise are shown in black. The visualization starts by showing the gradual inundation of [ -- and as ] sea level rises from today to around 7.5 meters above historical levels. 7.5 meters represents the estimate for sea level rise by 2300 under a business-as-usual scenario. You will see the visual pause to show the extent of inundation by -- under a worst-case scenario by 2100, in which sea level rise by approximately 1.5 meters. As you can see, a significant number of assets are at risk of inundation in Manhattan and in New Jersey, plus key infrastructure such as the JFK Airport in Queens. At 7.5 meters, New York City is transformed with large areas of all boroughs inundated by sea. The next visualization focuses on the potential impact of sea level rise on S&P 500 real estate assets in The Netherlands, one of the most well-adapted countries to flood, sea level rise and storm surge risks. As shown, by 2300, large areas of The Netherlands could be completely inundated under a worst-case scenario. This, however, does not account for the adaptation and resilience measures already undertaken and planned for The Netherlands. Today, around 1/3 of the land area of The Netherlands is below sea level, including key cities such as Rotterdam, which is home to Europe's largest port and has 90% of its land area below sea. Currently, these low-lying areas are protected by a huge network of dikes, spans and seawalls, along with movable storm surge barriers such as that protecting the ports of Rotterdam. Rising sea levels will likely require further development and the adaptation measures creating opportunities for investment. However, more extreme conditions may require a more frequent closure of storm surge barriers, restricting access to ports and creating economic disruption and losses in the future. The final sea level rise visualization focuses on S&P 500 real estate assets in and around the Gulf Coast region of the U.S.A., and that visualization should be loading up and playing now. As shown, rising sea levels present a particular threat to Southern Florida, in particular, which is seen as one of the most vulnerable cities -- sorry, Miami, in particular, which is seen as one of the most vulnerable cities to sea level rise globally. A recent study by Resources for the Future found that by 2040, areas populated by over 0.5 million people could be regularly flooded, threatening over $145 billion in real estate value. Moving on to the next visualization, and I'll just wait a second here to -- for it to load up. So this visualization represents projected increases in heatwave days per annum between 2030 and 2050. Darker shades of red represent increasing number of heatwave days per annum. Heatwaves are most intense around the equator. They can be seen to be increasing in frequency and moving north and south as time progresses towards 2050. This visualization shows the location and change in heatwave scores for the metals and mining sector through to 2050. The larger the bubble, the greater the magnitude of risk exposure from heatwave for individual mining properties. On to the next visualization, this time on wildfire risk under a high climate change scenario through to 2050. As shown, there are significant hotspots of wildfire risk in the West Coast of the U.S.A., Southeastern Australia and in the Amazon Basin in South America. We now overlay S&P power utility assets and show the increase in wildfire risks through to 2050. A number of high-risk assets can be seen in California, U.S.A and Victoria, Australia, both of which have experienced severe wildfires in recent years. The connection between the utility sector and wildfire is particularly important, with electricity networks being implicated in the initiation of wildfire and also being disrupted by wildfire themselves. PG&E filed for bankruptcy in 2019. They drew over $30 billion in liabilities due to the role the company played in wildfires in California in 2017 and in 2018. Now on to the next visualization. Physical risk, as we presented here, often represents the impact of climate change if there is inadequate climate action, and the global economy does not decarbonize in line with climate goals. However, transition risk, on the other hand, represents the impact of climate change if countries around the world ramp up their decarbonization commitments. Policy that focuses on carbon emissions may offer most promise with carbon pricing mechanisms, including carbon taxes, emissions, trading schemes and fuel taxes, expected to feature prominently in these global efforts to address climate change. The challenge is that carbon prices are currently too low. And Trucost research shows that carbon prices would need to increase by sevenfold to around about $120 per tonne by 2030, and this will vary depending on sector and geography. The visualization and the slide that follow showed a potential increase in carbon pricing across the globe with countries in Central and South America as well as the Asia Pacific region likely to be most impacted. On the next visual and on a slightly more positive note, Platts -- S&P Global Platts projections show renewables will continue to grow globally at a much faster rate in percentage terms than oil and gas from now until 2040, rising 5.2% in that span compared to oil and gas growth of just 1.3%. In this visual, locations of renewable power sites are in green, nonrenewable power sites are in red and sites with both are in yellow. And as you can see, lots of green and yellow lights flashing through time. So just to conclude this section. I think as we've shown, companies will be increasingly exposed to climate change physical and transition risks and will be impacted differently based on the geographic distribution of their assets. Our research shows that there are no sector or patterns, and that in-depth analysis will be required at the asset and company level, encompassing the entire supply chain and upstream product portfolio. The multi-asset portfolios of financial institutions are equally exposed. In other words, climate risk is financial risk, and this is creating demand for better climate analytics that are forward-looking, scenario-based and linked to financial impact. Now although global climate action has often ended in political stalemate, as we emerge from this pandemic, we may start to see countries mobilizing strategies that align with global climate goals and respond with renewed vigor in tackling the crisis. The early signs are certainly promising. There are also ongoing initiatives such as the Task Force on Climate-related Financial Disclosures, the TCFD, that are helping increase the transparency of climate risk across capital markets so that market participants have the information they need to make better decisions. So with this in mind, back to Paul.

Thank you, Steve, for that insightful presentation. And those visualizations, I think, really bringing that home. Next, I'd like to introduce our next speaker, Lauren Smart, Managing Director and Global Head from Trucost. Lauren will share her presentation on understanding and navigating climate risk at the asset level. Over to you, Lauren.

Great. Thanks very much. And thank you, Steve, as well for the visualizations, and I'm delighted as well that the technology worked to enable those to go ahead as well. So I'm going to spend a few minutes now just talking a little bit about the practical application of some of these datasets and analytics for both companies and investors. Many of you will have heard of the TCFD, the Task Force for Climate-related Financial Disclosures, and their recommendations. This has been driving real changes in terms of how companies and investors think about climate change and how it is linked to financials and how potentially it could affect the company or investor's returns. But it is challenging as well. There's a lot to think about. There are the risks from -- transition risks, so things like changing policies and regulations. And certainly, we're seeing that across the APAC region, [ after ] new policies and regulations that will increase the cost of carbon potentially or make technologies -- some technologies more cost effective and others less. There's also market changes. Consumer demand is changing, and that obviously has implications for products and services and also for consumer reputation -- company reputation. Nobody particularly wants to be associated with being on the wrong side of green trends or in terms of green transition and the way in which the market is moving and consumers are consuming. There's also opportunities. Every risk presents an opportunity. So some companies are going to be on the right side of the economic changes that we're seeing and the green transition. And there's also some companies that will be on the wrong side. And really, the whole point of the Task Force for Climate-related Financial Disclosures is to put companies and investors in a stronger position to understand where the risks might lie within their portfolios of assets, within their business models, and therefore, to be able to make changes, to become more resilient. And I think particularly in the current economic environment, building resilience in our companies, in our investments, in our economies is something that's going to only increase in importance going forward. So let's have a look at some of the ways in which that can -- companies and investors can do that. I talked about both companies and investor because actually the TCFD has developed significant support from across both parts of the -- both parts of the spectrum and also from government entities as well. The chart you're looking at here is from June 2019, and it shows that there are 785 different signatories, of which 374 are financial, 297 were nonfinancial corporates. There are central banks, 36 central banks and 5 government supporters. That number now and as of February 2020 was up to 1,027 supporters, and the market capitalization of those supporters is $12 trillion. So this is not a fringe initiative by any stretch of the imagination. This is an initiative, which is very much mainstream. And also, we're seeing significant uptake in Asia, in particular in Japan for TCFD. So in 2019 -- back in June 2019, there was a status report done by TCFD to understand how companies and investors were getting along in terms of understanding and reporting their climate-related financial risks. And they found that there've been significant increases in disclosures related to climate-related financial risks since 2016, but that there were still gaps. There was one other finding that, that -- was that more clarity is needed on the potential financial impact of climate-related issues on companies that companies are struggling a little bit with the use of scenarios. The majority don't disclose information on the resilience of their strategies, and that the mainstreaming of climate-related issues requires the involvement of multiple business functions across an organization and that there's capacity building to be done in order to train up those different functions in terms of understanding what climate risks means from a business perspective. So those are some of the areas that TCFD has been working on, and obviously, that a number of organizations like ourselves are also looking to help to support our clients with. Just sometimes when we're speaking to clients and they're asking about TCFD or climate risks, there's a hope, perhaps, that there will be one magic bullet number that we can plug into our models and it will tell us everything we need to know about climate risks and opportunities and resilience. Sadly, I don't think there is just one number. There is a range of different numbers. So in the same way that you would understand the financial resilience of the company by looking at a range of different metrics, that you would value a company by looking at a range of different metrics, that is the same for climate risks, too. So there are a range of different metrics because there's different questions, and different questions require different answers. We can look at things like carbon footprinting, which will tell us about the carbon emissions related to a particular organization or its investments. But we can also look at its preparedness for future carbon pricing. That's a different type of set of metrics. Physical risk and the exposure of the asset base to climate-related physical risks is a different set of datasets to analyze. What's the exposure from fossil fuels and stranded assets? Coal exposure. Again these are different sets of data. So what we have tried to do is to synthesize as all the different datasets that you might need in order to understand climate risk from all these different facets, the different facets of climate risk so that -- to make the process a lot easier. And then we've also developed a different range of scenarios so that you can stress test your organization. And let's have a little look at what that looks like in practice. So some of the datasets that we've put together that help to analyze companies, transition risk and physical risk. So we have carbon earnings at risk. This is an assessment of what the potential exposure is to increases in carbon pricing going forward. So as many of you will know, one of the key policy levers that governments have in order to meet their Paris Agreement goals and the drastic reductions in carbon emissions is to implement a price for carbon. So that can be through a taxation policy. It can be through some sort of carbon price cap and trade scheme. There are different ways in which it can be implemented. But all of them are essentially seeking to increase the cost of carbon change, the cost-benefit dynamics. We have done an analysis of what the price of carbon is to the different industries, in different countries and what it is now and under different future policy scenarios so that you can check what that gap is between a current price of carbon that a company or an investment is paying and what it's likely to be in the future. And that gap obviously gives us an indicator of potential risk. And then we can look at that relative to EBITDA to understand how that might fit into a company's profits at risk or also into other types of financial analysis that we can understand potential value at risk. And we'll hear a little bit more about the application of that to credit analysis later. We've also developed 2-degree alignment, so what does the world need to look like in the future and how aligned is the company's portfolio or an investment portfolio. And we've also looked at physical risk. So we've looked at 7 different climate houses. We saw some of those presented by Steve just a little earlier in this webinar. They're looking at things like heatwaves, cold waves, wildfires and droughts, flooding to understand what the potential impacts of those might be on different assets and over different time frames. Then we have provided some tools. We've developed tools that enable a company to look at these -- or an investor to look at these through the lens of their portfolio or through the lens of that particular company's asset base. And here, we have a couple of examples and extracts from reports that look at that. This is an example of an investor. We're looking at a portfolio analysis. So again, you can see here all the different companies within the portfolio. We can see the physical risk posed by the different climate -- by the different -- the 7 different metrics that we look at in terms of physical risks. So we've got physical risk score indicators. And we can, again, look at that portfolio through different lenses, essentially to be able to distill which of the investments and assets are potentially at greatest risk. And then what do investors do with this type of information? Well, some are using it to divest. So we've seen an increase in the number of divestments related to fossil fuel, but we're also seeing investors wanting to reposition portfolio so that they've got an increased exposure to green assets. So particularly in the Asian market, we've seen an explosion in the green bond market and we've also seen the introduction of green taxonomies to enable investors and banks in particular, to understand which parts of the economy should be financed in order to increase capital flows in the green transition. And then, of course, ultimately, clients in the investment space are wanting to increase resilience to maybe identify alpha or reduce downside risk. They're wanting to understand where risks lie so that those can be managed within the portfolio and potentially new investment products created. Some clients are wanting to engage with companies in their portfolio or to use the analysis in order to monitor the transition of companies within the portfolio as well over time. For corporate, all this data as well, of course, can be used for better decision-making. So if you are a company, understanding what the carbon price that you're paying now is and how that might change in the future is obviously extremely important in understanding where you might place new projects that might be carbon-intensive in terms of understanding what your cost might be in the future. And so we're seeing increasingly best practice for carbon-intensive companies is to have a carbon price that they use in their internal analysis of different projects. And here's an example of just that. Also, it stands to reason as well that if you are a company with significant physical assets, that understanding what the exposures of those to physical risks from climate changes is absolutely critical. As we know, physical assets are difficult to pick up and move around and have a very long lifetime. So understanding where you're going to place new physical assets or where you'll be buying new physical assets or what the risk exposures might be within your existing asset base is critical in terms of long-term planning and building that resilience within the business model. And obviously, it's not just within your operations, but within your supply chains, too. And here, we've got an example of what that analysis can look like for physical risks for a company and how we can map out all the different assets and the size of those assets and the locations of those assets using the latitude/longitude coordinates to get a very, very pinpointed assessment of what the potential risks might be. And of course, the same approach can be applied to a bank. We don't need to just have listed assets. We can look at private assets too so long as we've got that longitude and latitude information to enable us to understand what the risks are at a particular location. And an additional area that we've looked at in quite a lot of detail and actually developed a specific offering for is the metals and mining sector. So we have huge amounts to asset level data on the metals and mining industry. We have looked at what the water risk is as well associated with different mines in different locations. As many of you will know, mining -- many types of mining industries require huge amounts of water. So understanding what water risk exposure can be is super important as well going forward. So we can look at water stress, and we can also look at the other physical risk indicators that we talked about. We can also look at what the future commodity alignment would be because many of the green energy technologies that are -- that need to increase in the future also have a significant requirement for different types of minerals, so on metals and minerals. So understanding where the alignment is within a company's portfolio of assets to these green technologies is also a significant area of interest for many clients. And I should also add that we -- that the CSR aspect, the Corporate Social Responsibility aspect is obviously another important one, too. Companies are increasingly recognizing that for all stakeholders that can include employees, suppliers, clients, that having an understanding of your broader responsibility to society is even maybe even more critical now than ever before. And so being able to articulate what you're doing about the environment as well as what you're doing to build resilience within the business and within your investment portfolio is super important. And what we're looking at here is an example from S&P Global. We think it's really important to walk the walk. So we have also signed up to the TCFD. We are supportive of the TCFD. And we have also produced our own TCFD report, which you are very welcome to look at online on the link here, too. And on that note, I will pass back to Paul.

Thanks very much a lot, Lauren. It's a fantastic insight. Our next speaker is Andy Liu, Senior Director and Analytical Manager from the Corporate Ratings team within S&P Global Ratings. Today, Andy will talk about how climate risk is reflected in credit rating assessments. So over to you, Andy.

Thanks for the introduction, Paul. So I'll take a few minutes, give you a quick introduction of how ESG and as well as climate risk get factored into corporate ratings. So there might be a misnomer there that, historically, credit ratings have not taken into consideration ESG risk. I'm here to dispel that. If you look at ESG, we actually have been considering them for quite a bit of time. The only thing we haven't done up to this point is really break that out separately into a stand-alone section and maybe providing more clarity with delineation about them. So in that effort, starting in 2020, we actually added the ESG section to about 2,000 of our corporate credit reports. But in addition to that, I would say -- as I've said, we published a series of sector report cards basically laying out, for example, in oil and gas or media entertainment, what some of the key risks facing those companies. And for higher coal-fired company or company-specific exposures, what are those specific ESG risk and as well as climate risk. And we are also highlighting how ESG exposures could affect cash flow, profitability, debt and also business risk and how severe is that exposure in terms of potential credit risk at some point down the line. And as part of that initiative, we actually did a look-back study spanning from 2013 to 2017 and looked at specifically whether an ESG factor was the driver behind a specific rating action. So if you just focus on the first column, corporate ratings, environmental was the driver for 106 rating actions; social, 42; and governance of 77. However, if you take a step back and look at a broader perspective in terms of [ fine ], 106 rating actions, specifically citing environmental factors, but on the how many instances the environmental factor actually come into consideration of the overall credit rating construction. And that actually extends the pie quite meaningfully. So if you look at a number of ESG references over the same period of time, that expands almost -- that expand almost sevenfold to over 700, and social almost expanded 9x to close 350 and governance, almost 4x to about 260. And if you want to think about percentages of rating actions or -- excuse me, if you want to look at the number of rating drivers and in terms of number of rating actions that represented by ESG factors, it's about 10% over that period. So it's a pretty meaningful number. This is a graphical representation of our criteria framework. And for this audience, the more interesting portion is actually the part with the red arrow bars that indicate where ESG factor actually get incorporated or considered as part of the rating framework. So if you look at the right-hand side, hopefully, the font isn't too small for you to read, it says management and governance modifier. So the influence of governance is actually very, very direct. But in that instances, we actually are also considering the company's enterprise level risk management about environmental and social factors as well. So very, very often, when it come into play, it actually just not -- it's not just focusing on specific factors. Very often, you'll consider all the factors as well. And if you look at industry risk, obviously, industry risk, we're looking at longer-term industry growth trends, whether it be a positive/negative influence from environmental and social factors. And for competitive position, we're looking more granularly at a company's potential risk or opportunity from environmental and social exposures. And later on, I'll cite a specific example on this one. And ultimately, we have to consider whether those ESG factor or ESG risks and opportunities would translate into some sort of financial impact. And given the situation, we're looking at ratings, we're looking specifically at earnings, cash generation and financial commitment. And obviously, we will translate that into our financial forecast and our leverage assessments. So just dig into a little bit in terms of rating action related to environmental climate risk. And this is broken up by subsectors. Not surprisingly, if you look at the top, energy and utility dominated to the percentage terms of rating action related to environmental climate risk. But as you go down the line, you realize that some sector you think might be somewhat shelter are actually still pretty exposed. One example would be business and consumer services and going to the line to auto suppliers and capital goods manufacturers as well. And I'll close the short introduction today with an example of our ESG section. Alterra Mountain Company is a ski resort operator -- excuse me, ski resort operator based in the U.S. It has ski resort in the Northeast, U.S. West Coast, also around Vancouver area. And this is the prime example of a company whose credit risk exposure is really dependent on climate risk. So actually, I used to be a ski resort analyst for many, many years. And as you imagine, its snowfall for one season is great. Their number would be really, really good. And I can tell you from firsthand experience snowfall has been much more volatile over the last 2 decades versus the preceding 3 or 4 decades. And this has resulted in much more snowfall variability, but also revenue and profit volatilities as well. And as an effort to offset that, you see a lot more ski resorts and this apply for Vail Ski Resorts as well pushing out the ski pass products, right? Essentially, if a skier buys the ski season pass before the season starts, he or she have no idea how snowfall would be this year. But also, in case the snow for at the ski resort right next door run into any sort of snow issues, the ski pass will enable him to go to another company resort, perhaps a different geographical location. Also, the geographical dispersion of the ski resort also help reduce part of that risk. So I thought this would be a pretty interesting example of how climate risk figure directly into our ratings. And with that, I'll pass you back to Paul.

Thank you very much, Andy. I think you've done a great way to put a spell about the premonitions and so on. And there's a few questions that have come out. I know we've got a few questions kind of until the end, so we'll get through the last presentation today then move on to Q&A. So as the last presenter for today, I'm going to take you through some of the work that we've been doing here at S&P Global Market Intelligence to look at the linkage between climate change and credit risk, specifically how we have begun to develop our statistical credit analytics to provide insight into how future climate scenarios may impact credit quality. Before we get into the specifics of the tools that we've developed, take a look at credit risk and in climate change, let us just very briefly recap those main risks and transmission mechanisms are created when we're looking at climate change events. Now as Lauren has already covered in a great amount of detail with regards to the TCFD recommendations and the frameworks there, we can broadly categorize the risks to 2 main dimensions: physical risk and transmission risk. Now physical risk is, as we've seen, primarily the direct risks of climate change. It can be acute, i.e., event-driven, or it can be chronic, i.e., longer term. Transmission risks are those risks that arise from the transition of the economy from its current state to one which mitigates the impact of climate change. So it is primarily policy-driven. It kind of rise in legal, technological market, reputational dimensions, as we've already seen. And as we all know, carbon pricing is one of the main policy tools that's been adopted by governments to facilitate this transition to a low-carbon economy. This is important to note because when it comes to credit risk modeling, the ability to understand the changes in a company's fundamentals profile, driven by changes in the cost of carbon is really a key approach that enables us to then understand directly how climate change will potentially impact corporate credit profiles. So as a result of the combination of these risks, but also potential opportunities that arose due to this transition to a low-carbon economy, we can see that these poses serious challenges for practitioners from a strategic planning perspective, but also from a risk management perspective. So much so that the regulators and our financial service companies are actually beginning to explicitly require companies, financial service providers to include climate change risk in their documentation and reporting. They're including climate change risks in the stress testing exercises. So one of the most notable of these is the Bank of England, our prudential regulation authority. So really, it's clear going forward that it's going to be critical for all market participants to understand climate change transmission impact, both for risk management, but also for regulatory purposes. When we look at banks and financial service providers, even though scenario analysis is routinely employed at banks' risk management departments, climate change really does pose some new challenges and some of the new questions, and we've kind of highlighted some of the specific questions that have already arisen. What data could be used to examine a company's emissions? What's the geographical distribution of those emissions, given that they may be exposed to different carbon pricing regimes depending on the origination of those emissions? What scenario should we consider in each country or industry sector? How many scenarios should we be looking at? What is the time horizon we should be modeling over, given that climate changes is generally a longer-term time horizon? What kind of time horizon can be expected to legitimately model for? What methodology existing connects these transition risks back to intrinsic credit quality of a given corporate entity? Had we appropriately addressed the risks, but also assess opportunities created by this transition to a new low-carbon economy? What we've done is we've worked to identify and also address these questions. And we've developed a number of modeling frameworks. The first one estimates the impact of climate transition risks on the credit risk of upstream oil and gas companies, and it uses a fundamentals-based credit analysis approach. Secondly, we developed an approach for public companies across all industries by using market database credit analysis. And we're going to walk you through these at a high level today. So primarily, our 2 credit analysis frameworks differ, and that one is a bottom-up fundamental-based approach. As we mentioned, it only applies to upstream oil and gas companies. Whereas our other approach is a market-driven or a top-down market database approach, uses market database credit models, and applies these models to publicly listed firms across all industry sectors. I will take a quick walk through these approaches now in the time that we have. But just so you're aware, we have also produced 2 dedicated webinars that cover both of these frameworks and their methodologies in a lot more detail. These are available, fully referenced on-demand via the links provided in the content widget on [ the ] page you're currently viewing, or feel free to reach out to us and we're able to register and review those webinars that go into a lot more detail on these approaches. So first off is our fundamentals approach. We developed in consultation with Oliver Wyman. This approach, we specified that we were going to look primarily in the upstream oil and gas sector as being an industry sectors, particularly going to be impacted by obviously carbon pricing and a transition to a low-carbon economy. So we take financial data for our upstream oil and gas sector companies, and then what we do is we adjust those financial statements based on specific climate change scenarios, which then give us pro forma balance sheet, cash flow and income statements according to those specific scenarios and the parameters that we specify. Now these scenarios are predefined scenarios, which we based originally on either a very simple global carbon tax, which we looked at across $20, $50, $75 or $100 per tonne of CAT, or you have the option to choose a more complex and integrated macroeconomic model, corporate mine model, which was developed by the Potsdam Research Institute for Climate Research. It's a widely recognized multiregional model, which incorporates the economy, the climate system and the energy sector. Oliver Wyman then provided the linkages from these broad-based energy transition risk scenarios to create for our financial model based on things like price elasticities and demand, supply of energy sources and industry and academic imperative benchmarks that would adjust and create pro forma financials. These pro forma financials are then run through our statistical credit analytics engine, called credit model. This is a model trained on historical S&P Global Ratings. It's integrated with financial statements available on the S&P Global Capital IQ platform. And the end result is a scenario implied credit score, in line with the S&P Global Ratings credit scale or a probability of default over a specific time horizon or a given term structure based on these long-term adjusted financial metrics. Here, we have a simplified visualization of this methodology, which first takes the climate scenarios that we've specified by the user at step 1. And then based on that work done by Oliver Wyman, we adjust those company financials based on 4 key drivers, which tally the impact of specific scenario that we've selected on a company's financial statements. Then based on each of these baseline financials that we get from the S&P Capital IQ platform or from user-defined inputs, we can create our scenario adjusted financial statements on a company level. Those then in turn run through our fundamental credit scoring model to create our final output, which is scenario-adjusted credit scores. Now this framework provides an excellent and granular understanding for oil and gas upstream sector. But as we start to expand our understanding of the impact of climate change in credit risk outside the specific sector, we realize the limitations in maintaining this type of fundamentals-based approach for each individual sector given that it relies very heavily on industry-specific key drivers, as we can see on this slide in Stage 2. It really gets quite difficult for us to develop those for each individual industry sector. So our next approach is developed with that fact specifically in mind. We really sought to expand our understanding of other sectors and the impact of climate change on credit risk through a market-based rather than fundamentals-driven framework. So this would capture more of the market across all industries. Our market-based approach relies heavily on the data that we have access to through our Trucost emissions dataset, which as Lauren already mentioned, covers around 15,000 companies globally across a various -- variety of scope of emissions, industries and regions. In addition, we really leveraged the transition scenarios that Trucost have created to inform our model assumptions. We take the transition scenarios defined by Trucost, and I'll start with our market-driven approach. We again focus on carbon pricing as the primary mechanism, the transition to a low-carbon economy, and that linkage back to company level credit risk. Now our scenarios are based on slow, moderate and fast scenarios defined by Trucost, expand the years 2020 and 2050 and cover 44 major economies and all industry sectors. Our market-based approach relies on our market signals-based credit model, PD Model Market Signals. This model is a Merton's structural credit model. It generates daily probabilities of default based on market capitalization volatilities for publicly listed companies. The framework we developed first takes the Trucost-defined scenarios and then considers the additional carbon tax levered on companies under each given scenario. This, in turn, then leads to a company level operating expense change. The next step is then to consider the transition cost, which obviously leads to a reduction in CO2 emissions, which we based on Trucost scope 1 and 2 emissions for the company in question and those forecasted CO2 reductions under each of those transition scenarios we mentioned earlier, slow, moderate and fast. This reduction in CO2 emissions over a time horizon leads to, again, a further company level operating expense adjustment. Next, what we seek to do is we seek to capture the transition opportunity. If you adjust through a change in market share, we base this upon a number of proxies for company investments and company firepower. So for example, we use historical CapEx. This then leads to a revenue adjustment based on whether the company has been able to capture additional market share or has lost market share. And that then leads us on to a new EBITDA. Now finally, we seek to use our adjusted operating expenses and our new EBITDA to produce a new market capitalization for the company in question. This is then based on those climate link scenarios that we have already defined. That market capitalization volatility can be set into our PD Model Market Signals to produce a new implied credit score or probability of default. Now we've given you a very quick overview of these 2 approaches and really how we're seeking to link that Trucost brainwork and Trucost data back into understanding the broad-based credit transitions for corporate profiles. Obviously, it is quite methodologically complicated. I do suggest that you reach out to us further for further detail. And as I mentioned earlier, please do refer back to those on-demand webinars for both of these frameworks, whether it's fundamentals or market based. With that in mind, let us now move to the Q&A section of today's webinar where we can open it up to the audience for additional questions. So as a reminder, just before we kick off, I know we've had a lot of questions that have come in certainly through the Q&A widget. But if you haven't submitted a question and you do have them for today's presenters, you can submit questions through the Q&A box or by clicking on the Q&A icon at the bottom of your screen. We'll answer as many as we can today. But if we don't get around to you, someone will follow up with you after the webinar. And I'm almost certain, given the number of questions I'm looking at, that we will have to follow up with a number of people.

So let's kick things off with a question for Andy. Andy, we're aware that ESG-focused operations are very important. However, hardly any -- very few investors are interested in ESG-related information. In view of this, how do we see the business value in the company, the correlation from ESG disclosure? Andy, do you want to take that question for us, please?

Sure. I would actually make the argument that investors are actually really, really -- is really interested in ESG information. We have a lot of meeting with investors. We have a lot of meeting with companies, and the question is really not around in terms of the investors are not interested or companies are not interested, it's really how do investors and also company come together and provide ESG information on a more consistent basis. So investor interest is really geared towards [ fine ]. Let's say, a company has an ESG -- some sort of ESG disclosure whether it's TCFD compliant or not, then someone else has a different kind of disclosure. Is there a more standard way of benchmarking this ESG disclosure to a more consistent basis such that they could do that or modeling -- or do some sort of modeling to see how exactly ESG risk while opportunity translate to potential risk opportunity for investment opportunity? So I would say there's a tremendous amount of interest. But right now, they're still looking at the market for potential solution to this lack of benchmarking. And to some extent, there's a chance that some of the audience on the phone are aware of S&P ESG Evaluation product, and that's actually what the ESG Evaluation product is actually attempting to resolve, basically provide a more standard benchmark or looking at ESG risk and opportunities. Thanks, Paul.

Thanks so much, Andy, to provide a little bit of clarity there for us. Lauren, just a question that's come in for you. I think question here, are there any metrics that companies use to track climate risk and review the impact of mitigation efforts? I think that's been posed by a number of attendees in different forms. So if you want to play that one for us.

Sure. Absolutely. So I'll go back to what I said earlier that there's no one single metric, but there are definitely an emerging set of metrics linked to transition risk and to physical risk. So measuring the traditional carbon footprint of a company, of an investment portfolio, of a supply chain or even of a product is a starting point, and there's some really well-established methodologies for doing that. And that's something that can be used and tracked as a baseline. So we're increasingly seeing investors and also sovereign wealth funds as well, reporting the carbon footprint of investments, for example, and then tracking that year-on-year to show the changes over time. Also, we're seeing clients looking at the carbon earnings at risk and measuring that against a benchmark and comparing -- and using that also to measure the change over time to help understand how changes in their portfolios are helping to mitigate that risk. There's also the 2-degree alignment metric, which I mentioned. The stranded assets exposure is another very frequently used metric as well to demonstrate again how that's changing. And also metrics that help you to understand what can be referred to as the green-brown shift. So how is a portfolio transitioning over time and is there increasing exposure to green technologies and a reduction in exposure to fossil fuel-intensive ones. So those are just a few of the different ways in which -- well, few different metrics that are being more increasingly reported on as part of TCFD reporting.

Got it. Fantastic. I think I'll take the next question before -- I've got a question, I think, for Steve to take. But the question displays around how do you back test a quantitative model for the credit risk impacts of climate change? That's an excellent question. It's very difficult to back test a quantitative model, something that is kind of an event that is something we've not faced before, right? What we try to do here is we use models that are -- credit models that are already used for counterparty credit risk that are based on established methodologies, right? So all of these models are back-tested on their ability to predict things like corporate defaults, their ability to align with the historical rating universe, for example. And then the [ impetus ] that go into these scenarios that feed those models, we try and ensure obviously based on very rigorous methodologies. So having that access to that data from the Trucost database, things like carbon earnings at risk, really gives us a very solid quality of data that we can feed into these models that we're able to back test on more traditional default kind of patterns. So it's very difficult to back test quantitative model for the credit risk impact of climate change, but we try to mitigate that by ensuring that the quality of data that goes into those models is very high. And also the standard of the methodology for those models is also very high as well, really heavily on an extensive team for that purpose. Steve, I've got a question for you here. I think you're the first person that's going to take the inevitable COVID-19 question of today's webinar. So how do you think COVID-19 will affect the global response to climate change, renewed sense of urgency or opportunities or complacency thanks to the reduced emissions in the first half of this year. Over to you there, Steve.

Sure. Yes. Thanks, Paul, yes. I mean, I touched on a couple of points in my presentation. We started to see reports on the kind of linkages between the COVID-19 outbreak and climate issues, as I mentioned, sort of improved air quality in major cities because of lockdowns, with scientists estimating that we should see global CO2 emissions drop by about 5% this year, which would be the largest fall since the second world war. And I think, obviously, that's starting to put climate change in focus and sort of discussions around how will we respond when the immediate sort of health crisis and economic downturn are over. And I think we will kind of be presented with a choice. Countries could, for example, lean on sort of carbon-intensive energy and low -- low oil, historically, low oil prices, which would see carbon emissions bounce back heavily, or there's an opportunity to kind of accelerate the transition to a lower-carbon economy and use this opportunity to build resilience. And I think the early signs are promising. In Europe, for example, talk around the green deal as a stimuli package that would promote the transition whilst also promoting jobs and prosperity. But I think there is certainly an opportunity for companies themselves as well to start thinking about how they respond in a way that's maybe more aligned with global climate goals. We did some research on this recently, and we'd be very happy to share that with the participants today on things like trade and commuting and business travel and how they could start to be more aligned with the global climate goals, which would see us kind of bring carbon emissions longer term down below 2 degrees, which are the goals of the Paris Agreement.

Thanks so much for that, Steve. And hopefully, it's definitely an opportunity pieces, right? Certainly, a once in a lifetime thing, hopefully. So I think we have a lot more questions that we haven't been able to get to today, unfortunately, due to time. We will reach out to everybody that's posed questions and come back to you. Just to wrap up for today, thank you very much for joining today. We really hope that you find that informative. We do appreciate you joining the webinar under such trying conditions. At the end of this webinar, you are able to share your feedback with us via the survey that will launch at the end of the webinar. The slides and the replay will be available from today. We will e-mail them directly to you. On behalf of S&P Global Market Intelligence, thank you very much for your participation. Stay safe, and we hope you join us again soon.